Net Asset Value – NAV: Value Investing
What is NAV? From an investing perspective, NAV is Net Asset Value.
How to calculate Net Asset Value (NAV). Calculating Net Asset Value is theoretically as simple as: NAV = Total Assets – Total Liabilities. There are some differences in the calculation of NAV depending on what type of investment is being examined but the overall principle is the same.
Value Investing Strategy: Buying at a Discount to Net Asset Value (NAV). A value investing strategy that is common among value investors is to buy stocks that are trading significantly below their NAV or Net Asset Value. This provides a margin of safety. Some value investors will also deduct the value of intangible assets from their calculation of NAV. One of the first value investing strategies published was to buy stocks trading at a discount to their Net Net Working Capital.
Mutual funds – Net Asset Value per Unit (NAVPU). NAVPU is the dollar value per mutual fund unit after subtracting the funds’ liabilities from the assets and then dividing that figure by the number of units issued and outstanding. Typically, liabilities of most long-only mutual funds are relatively low compared to the amount of assets. Generally speaking, mutual funds are quoted at NAVPU and can be sold or purchased at a price equal to NAVPU less transaction costs. Mutual funds are often referred to as open-ended funds because they can be bought and sold at NAVPU at most anytime.
Closed-end Funds – Net Asset Value per Unit (NAVPU). The NAVPU for closed-end funds is calculated in the same manner as mutual funds or open-end funds – i.e. total assets less total liabilities divided by the number of units issued and outstanding. The difference with closed-end funds is that they are typically not redeemable by the investment manager. Investors in closed-end funds looking to liquidate or cash-in their position must generally do so by selling their units to another investor which is often done so at a discount to the NAVPU. Closed-end funds often trade on exchanges like any other stock. This makes closed-end funds susceptible to the day-to-day supply and demand of the units which also contributes to whether the units are trading at either a discount or premium. Closed-end funds often trade at a premium in a short period subsequent to an IPO but thereafter trade at a discount to NAVPU.
Common Stock: Net Asset Value Per Share (NAVPS). Basic NAVPS is calculated as total assets less total liabilities. This is also sometimes referred to as Book Value per Share or Equity per Share. Variations of calculating NAVPS can also include estimating a current market value of assets. Since accounting rules typically require companies to value assets at historical cost, there can be wide and significant variations between the book value of an asset and the current market value.
Common Stock: NAVPS for Commodity Based and Precious Metal Stocks. NAV per share is typically calculated and reported by engineers for oil and gas stocks as well as mining stocks. These calculations are generally required to be disclosed in regulated annual reporting forms. Engineers calculate NAV by discounting future net cash flow streams (i.e. discounting the revenues less operating costs and some capital costs). Stocks rarely trade at a price equal to NAV and could trade at either a discount or premium reflecting numerous other factors such as short-term supply and demand of a stock, investor outlook, whether or not a current sector is favoured by the market or not, differences in the discount rate used by Engineers versus investors, etc.
Net Asset Value (NAV) is an important component of value investing strategy. How NAV is calculated depends on the type of investment being evaluated as well as the assumptions that an investor makes in regards to each variable that is used to calculate Net Asset Value (NAV). NAV is another tool that value investors may use to evaluate a stock or any other investment.
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Related terms: Net Asset Value Definition, NAV Definition, How to Calculate Net Asset Value, How to Calculate NAV, Net Asset Value per Share NAVPS, Net Asset Value per Unit NAVPU, Net Asset Value Definition, NAV Definition
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Margin of Safety: Value Investing
Margin of Safety – Value Investing Criteria
Margin of safety is the basis of value investing strategy. The father of value investing, Benjamin Graham proposed in The Intelligent Investor that “to distill the secret of sound investment into three words, we venture the motto, “MARGIN OF SAFETY.[1]” Seth A. Klarman, a disciple Graham and famous value investor himself literally wrote the Margin of Safety book.
What is a margin of safety?
In our “Deep Value Investing Definition” article we wrote that value investing is about buying a stock at a sufficient discount to intrinsic value. Buying a stock at a significant discount to its intrinsic value allows the investor to have a “margin of safety.”
To help construct a margin of safety definition, Graham contends, “We have here, by definition, a favourable difference between price on the one hand and indicated or appraised value on the other. That difference is the margin of safety.[2]” Graham explains that a margin of safety can only certain if reasonable and rational analysis can demonstrate that the price paid for the stock is substantially less the value of the underlying assets.
Warren Buffet describes this succinctly, “Price is what you pay. Value is what you get.” The value investor looks to pay a price much less than the value received – and that difference is the margin of safety. In other words, value investing is about buying a dollar for fifty cents – therein lies the margin of safety.
Very simply, Joel Greenblatt explains in The Big Secret for the Small Investor that the concept of margin of safety is about “leaving a big space between the value of what you are buying and the price you pay.[3]”
Why is a margin of safety important?
In Margin of Safety, Seth Klarman explains “that value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes.[4]” Buying a stock with a significant margin of safety reduces both the likelihood and severity of potential losses.
Value investors don’t just like to avoid losses though – they still like to make money, of course. Graham wrote, “A strong-minded approach to investment, firmly based on the margin-of-safety principle, can yield handsome rewards.[5]”
How do we get a margin of safety?
“The margin of safety is always dependent on the price paid,” writes Graham. “It will be large at one price, small at some higher price, nonexistent at some still higher price.[6]”
Klarman says that investors achieve a margin of safety, “By always buying at significant discount to underlying business value and giving preference to tangible assets over intangibles.[7]” Much of a potential return is earned as the price of the stock begins to reflect the underlying value of the assets.
In order for the gap to narrow, the investor must try to first understand why the discount exists and second, whether there are any catalysts that will help the stock rise to reflect the true underlying value.
Conclusion
Margin of safety is the central theory of value investing. First and foremost, a margin of safety first helps ensure the goal of preservation of capital and loss mitigation. It is about buying securities at substantial discounts to their actual value and then maintaining these holdings until the mispricing is eliminated by the market (or unless other information becomes available that could change the original investment thesis), thereby earning the value investor satisfactory returns.
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[1] Graham, p.512
[2] Graham, p. 517
[3] Greenblatt, p. 96
[4] Klarman, p.7
[5] Graham, p. 10
[6] Graham, p. 517
[7] Klarman, p. 68
Intrinsic Value: Value Investing
How to Value a Stock: Calculating Intrinsic Value
In our “Deep Value Investing Definition” article we wrote that value investing is about buying a stock at a sufficient discount to intrinsic value. This article will further discuss classic definition or the first widely published formula that was used to calculate intrinsic value. We also introduce other various valuation methods that some investors use to arrive at an estimate of a stock’s (company’s) intrinsic value.
The calculation of intrinsic value is as much art as science. Any investor can run a mathematical screen to identify stocks trading at various metrics that could indicate potential value. However, it must take keen business sense and deep curiosity to ask why a stock may be trading at the level it is, whether there actually is business value and how much, and what potential catalysts could emerge to unlock value.
To calculate intrinsic value, Benjamin Graham created a simple formula:
Intrinsic Value = E (2 * R + 8.5) * 4.4 / Y
where:
E = the company’s earnings per share
R = the company’s expected earnings growth rate
Y = the current yield on AAA corporate bonds
Graham advocated only buying stocks trading near or, preferably, significantly below its intrinsic value. (Source: Janet Lowe, Value Investing Made Easy)
Of course, the Graham’s intrinsic value formula assumes the company is a “going concern” (i.e. the company will continue to operate in a manner that allows it to earn revenue and contractually discharge its liabilities). This is quite different than valuing a stock on a “liquidation” basis which attributes little value to earnings (likely even a negative value for expected losses) and primarily considers the current market value of saleable assets after accounting for disposal costs. The details here are beyond the scope of this article but it is an important consideration worth mention.
The most successful value investor of all, Warren Buffet, was not always sold on the use of formulas. Buffet advocated buying great businesses at good prices. Buffet would first determine what type of business he wanted to buy and then waited to buy that business (stock) at a good price. Graham’s intrinsic value formula could be one tool to help assess whether the current trading price provides a sufficient margin of safety but Buffet always advocates that the first step is to identify great businesses.
In Value Investing, Greenwald et al. proposes that intrinsic value “is the discounted value of the cash that can be taken out of a business during its remaining life.” This is also commonly known at the Discounted Cash Flow (DCF) model. Of course, the calculation of DCF has many important underlying assumptions that can result in widely varying results. Consequently, it is not a model that all value investors rely upon nor is it a model that is supported in practice by Greenwald et al.
Further Discussion for Stock Valuation
Other methods of estimating or calculating the value of a stock include:
* Discounted Cash Flow
* Net Asset value (Book vs Market)
* Liquidation value
* Net Net Working Capital or Net Current Asset Value
* Other commonly quoted metrics: Price to Earnings, Price to Sales, Price to Book
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DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
Net Net Working Capital: Value Investing
What is Net Net Working Capital?
Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
“Net Net Working Capital” (NNWC) is one of the first stock valuation screening methods to be defined in the value investing world. Benjamin Graham also referred to this as Net-Current-Asset Value (NCAV).
The Net Net Working Capital formula may help identify undervalued stocks. Benjamin Graham actually used the term “Net Working Capital” but current value investors and Graham followers use the terms “net nets” or “Net Net Working Capital” interchangeably.
One value investing strategy of Graham was to purchase stocks that were trading at less than two-thirds of the Net-Current-Asset Value per Share (i.e. less than two-thirds of the Net Net Working Capital Value per Share). This type of value investing strategy could be thought of as a “liquidation value investing strategy”. In other words, Graham is proposing that the stock is so cheap that even under a situation where the business was wound down, that the investor would have a such a suitable margin of safety that a return could still be earned. Of course, Graham is not counting on a liquidation since there are costs associated with that action. Rather, Graham is satisfied that he is paying nothing for the fixed assets of the business nor is he paying anything for any potential earnings.
According to Graham, “The type of bargain issue that can be most readily identified is a common stock that sells for less than the company’s net working capital alone, after deducting all prior obligations.* This would mean that the buyer would pay nothing at all for the fixed assets—buildings, machinery, etc., or any good-will items that might exist. Very few companies turn out to have an ultimate value less than the working capital alone, although scattered instances may be found.” (Source: The Intelligent Investor by Benjamin Graham).
Of course, stocks that are trading below their NNWC may be trading at such low multiples for various reasons (e.g. pending bankruptcy, misstated financial statements, or a host of reasons why investors may be shunning a particular stock). Regardless, we present the Net Net Working Capital formula and provide further discussion.
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Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
Once the NNWC is determined, this amount divided by the number of shares outstanding will provide the NNWC per share. NNWC per share that is less than the current share price may be an indication of an undervalued stock or a deep value stock. Graham advocated buying a basket of stocks whose prices traded significantly below NNWC per share (or Net Current Asset Value per Share – NCAV per Share).
The NNWC formula considers that not all balance sheet amounts may reflect current reality. A 25% discount is applied to accounts receivable as these amounts may not actually be collectible. In addition, a 50% discount to inventory is applied given that it may be stale or obsolete. Of course, this is a first screen and potential investors should consider whether further discounts would be prudent.
The estimation or calculation of intrinsic value is as much art as science. Any investor can run a mathematical screen to identify stocks trading at various metrics that could indicate potential value. However, it must take keen business sense and deep curiosity to ask why a stock may be trading at the level it is, whether there actually is business value and how much, and what potential catalysts could emerge to unlock value. The Net Net Working Capital formula is one more value investing tool.
Net Net Working Capital Formula – Further Analysis and Discussion:
Net Net Working Capital is a subset of Graham’s Net Working Capital is a subset of Net Working Capital (also known as Working Capital).
1) Net Working Capital = Current Assets – Current Liabilities
2) Graham’s Net Working Capital = Current Assets – Total Liabilities
3) Net Net Working Capital = Cash + Short Term Marketable Investments + Accounts Receivable * 75% + Inventory * 50% – Total Liabilities
Note that the results of each formula are presented in a decreasing order. That is to say Net Net Working Capital will provide the lowest and hence, most conservative, value. In other words, all else being equal, of the three formulas above, a stock trading below Net Net Working Capital provides the investor with the largest margin of safety.
In our “Deep Value Investing Definition” article we wrote that value investing is about buying a stock at a sufficient discount to intrinsic value. Graham’s “Net Working Capital” or the “Net Net Working Capital” formulas can be used as preliminary screens to identify potentially undervalued stocks or deep value stocks.
Related Terms: Net Net Working Capital Formula, Net Net Working Capital Calculation, Net Net Working Capital Definition, Net Net Working Capital Change, Net Asset Value (NAV), Net Asset Value per Share (NAVPS).
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DeepValueInvestor.com is dedicated to value and deep value investing. Our website has a variety of resources including education, the latest deep value investing news, discussion on value and deep value investing strategies, related book reviews, deep value investing quotes, and our Coattail Corner newsletter that follows selected stock purchases of successful investors.
Copyright © 2011 by DeepValueInvestor.com. All rights are reserved.
Deep Value Investing Definition: Value Investing
Deep Value Investing Definition
What is deep value investing? What is the definition of deep value investing?
Value investing is about buying a stock for substantially less than what it is actually worth (i.e. its intrinsic value). Deep value investing seeks to purchase stocks at an even greater discount to their intrinsic value.
Value investors assert that “Mr. Market” often inefficiently prices stocks in the short-term for various reasons (e.g. forced stock sales, bad publicity, lack of analyst coverage, etc.). Once disciplined value investors have performed the required fundamental analysis of a business they will arrive at an estimate of the “intrinsic value” of the stock. This intrinsic value is compared to the current selling price and if there is enough of a discount, value investors will strongly considering purchasing the stock.
Some value investors will also try to determine potential catalysts (e.g. spin-off or sale of hidden assets) that could potentially cause other investors to consider a purchase or that could otherwise unlock value.
Value investors contend that purchasing a stock at a sufficient discount to intrinsic value or allowing for a “margin of safety” also reduces risk. The value investor believes that further price deterioration is less likely since negative opinions are already likely factored into the stock price. Further, existing shareholders who still haven’t sold their positions likely realize the value in the stock and may be unlikely to sell at such a discount.
The quickest way to learn something is to ask those who are masters. To explain the deep value investing definition, we turn to famous deep value investors such as Benjamin Graham and Warren Buffet. Other value investors such as Irwin Michael, Seth Klarman or Joel Greenblatt also have their own deep value definitions or deep value investing strategies.
Benjamin Graham and Warren Buffet believe that buying a stock at a sufficient discount to intrinsic value allows for a margin of safety. Buffet has modified his strategy somewhat from Graham by also considering franchise value and the earnings power, stability, and growth prospects of company.
Irwin Michael sums up his deep value investing philosophy by “buying toonies for loonies” (note: in Canada, a toonie is a 2 dollar coin and a loonie is a 1 dollar coin). Michael follows his “Ten Commandments of Value Investing.”
Joel Greenblatt believes that buying great companies (as defined by a high ROE or return on equity) at cheap prices (as defined by a low EBIT or earnings before interest and taxes) is the way to consistently outperform the market. In the words of Warren Buffet, “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Indeed, Greenblatt’s value investing strategy aims to do both – buy a wonderful company at a wonderful price.
Seth Klarman writes “Value investing is the discipline of buying securities at a significant discount from their current underlying values and holding them until more of their value is realized. The element of a bargain is the key to the process. In the language of value investors, this is referred to as buying a dollar for fifty cents. Value investing combines the conservative analysis of underlying value with the requisite discipline and patience to buy only when a sufficient discount from that value is available.” (Klarman, Seth A. “Margin of Safety,” p. 64.)
Klarman also describes the basic tenants of value investing. “There are three central elements to a value-investment philosophy. First, value investing is a bottom-up strategy entailing the identification of specific undervalue investment opportunities. Second, value investing is absolute-performance, not relative-performance oriented. Finally, value investing is a risk-averse approach; attention is paid as much to what can go wrong (risk) as to what can go right (return).” (Klarman, Seth A. “Margin of Safety,” p. 76.)
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Deep Value Investing – Education
Here we’ll look at deep value investing definitions, examine deep value investing strategies, review the personal characteristics and traits of deep value investors, explore deep value investing tools, study deep value investing historical returns, and much, much more!
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Deep Value Investing – Resources
Here you can find other helpful links to deep value investing tools, deep value investing professionals, world stock markets, various regulators, and more!
Deep Value Investing – Books and Reviews
A collection of deep value investing book reviews. Learn and read about the classics as well as modern deep value investing books.
Famous deep value investors share their knowledge and wisdom. In addition to deep value investing quotes, there is also a selection of quotes related to motivation, success and required personal characteristics.
Deep Value Investing – COATTAIL CORNER
“Coattail Corner” is our free value investing newsletter. ”Coattail Corner” will be dedicated to tracking the investments of famous deep value investors. Professional deep value investors are often required by law to disclose their portfolio holdings. Some deep value investors go further and engage the media to publicize their positions and highlight the investment attractiveness of the stocks they hold. ”Coattail Corner” will provide information on how to track the pros as well as provide selected information or articles on the portfolio holdings of professional deep value investors.